American gadgetmaker is accused of making profit in Italy, shuffling the money illegally to Ireland

Italy -- Europe's fifth largest economy -- is a lucrative market for U.S. gadgetmaker Apple, Inc. (AAPL), the world's most profitable tech company. But Apple's Italian profits have come back to haunt it after prosecutors in Milan, Italy filed charges against the gadgetmaker's local subsidiary, accusing it of breaking local taxes laws for at least two of the past three years. The investigation has not been made public, but was reported on by Reuters this week, citing "two [local] judicial sources with direct knowledge of the matter."

Local newspaper L'Espresso was actually the first to report the potential charges, which it learned of from its own sources. L'Espresso, a sub-brand of the Italian newspaper Repubblica, cites sources as saying the case involves $1.34B+ USD in profits which Apple shuffled out of the EU nation over the course of 2010 and 2011

To be fair, Apple's strategy -- the so-called "double Irish" tax avoidance tactic -- is hardly unique. Google Inc. (GOOG) and other top tech earners almost all heavily lean on this strategy or sheltering income in the Caribbean islands (e.g. the Cayman Islands).

On-paper, the general corporate tax rate in the U.S. is 35-percent, however, that figure is misleading as the convoluted U.S. tax code typically leaves a wealth of loopholes available for big businesses to lower their rates. Consequently, the average rate for Fortune 500 tech companies was around 16 percent in 2012 [source].

Apple's tax avoidance was on the more flagrant side of the spectrum, though as it only paid a 1.9 percent effective tax rate on foreign earnings, which it shuffled the bulk of its profits into. The numbers appear especially glaring given Apple's top ranking in profitability and the fact that the company has done some lobbying in the U.S. (a common route to getting "legal" tax handouts from Congress) -- but not as much as other firms like Google.

As an old Japanese proverb goes, "The nail that sticks out gets hammered down."

II. Apple Reportedly Paid No Taxes on $1.1B USD in Italian Profit

Apple defined itself with record setting earnings, boosted even higher with aggressive money shuffling to low tax regions -- now it's getting hammered hard. According to both Reuters and L'Espresso's sources, Italian authorities have alleged behind closed doors that in 2010 Apple shuffled €206M ($277.4B USD) in profit out of its Italian subsidiary towards a low tax subsidiary in Ireland. Had it abided by the law and disclosed the money it likely would have had to pay Italy's 27.5 percent corporate tax rate [source]. In 2011 Apple appeared even more emboldened, illegally shuffling €853M ($1.148B USD) out of the country, according to prosecutors.

The American firm refused to directly comment on its behavior in 2010 and 2011, instead saying that it always tries to follow the law and pointing out that at least it hadn't been accused of breaking the law prior to 2010. A spokesperson remarks:

Apple pays every dollar and euro it owes in taxes and we are continuously audited by governments around the world. The Italian tax authorities already audited Apple Italy in 2007, 2008 and 2009 and confirmed that we were in full compliance with the OECD documentation and transparency requirements. We are confident the current review will reach the same conclusion.

According to the allegations, Apple's Chinese manufacturer partners ship orders to subsidiary Apple Supply International (ASI), which then sells the devices at close to the MSRP value to local retail subsidiaries in Italy, the UK, France, Germany, and other markets. As the subsidiaries are buying the tablet at close to full price, they earn only a small cut of the profit, while the Irish company pockets most of the profit.

Apple's 2012 earnings have not yet been audited by Italian officials -- it is probable they may feature similar "irregularities".

III. The Man Who Helped Facebook, Apple, and Google Dodge Their Bills

Again, Apple is hardly alone here. Italian fashion icons Domenico Dolce and Stefano Gabbana were sentenced to 20-months in prison for hiding €343.3M ($462.0M USD) in profits. So far neither fashion executive has served any prison time, as their defense has appealed the conviction arguing in essence that the pair had no idea how their business was being run, from a financial perspective.

In the tech sphere Google and Amazon.com, Inc. (AMZN) are also being probed or charged with tax dodge by Italian regulators. Google allegedly hid [translated] €240M ($323.3M USD) in profits. Charges have not yet been filed against Amazon, although Reuters sources said it is also under investigation.

This is hardly a coincidence. According to a piece byBloomberg, Apple, Google, and other top firms all rely on Feargal O’Rourke, an executive whom it bills as "the scion of a political dynasty who heads the tax practice at PricewaterhouseCoopers in Ireland."

Feargal O'Rourke, head of tax services for PricewaterhouseCoopers LLP in Dublin, claims, "Under no circumstances is Ireland a tax haven." [Image Source: Bloomberg]

Mr. O'Rourke is cousins with Ireland's finance minister and has heavily lobbied the local government not to crack down on companies shuffling profit into the country and to keep rates low, even as international criticism mounted. Some companies like Apple push profit to Ireland and simply register their locations as "nowhere", hence paying no taxes to Irish collectors.

Others register in ultra-low tax rate Island nations, which Irish subsidiaries are legally allowed to shift profits to, untaxed. Google sends most of its Irish earnings to Bermuda, allegedly. LinkedIn Corp. (LNKD) sends its earnings to the Isle of Man. And Facebook.com, Inc. (FB) sends its profits to the Grand Cayman island. Either way, these approaches cut a company's tax rate to around 2 percent overall.

Google also dodges a lot of its tax load. [Image Source: OMG Droid]

Adding to the complexity, many companies -- Apple included -- don't even report these earnings as profits, hence their effective global tax rate appears more "fair" to members of the media in the U.S. and EU (unless you dig deep into the numbers and how the company's finance department is defining them).

IV. Pressure From Taxpayers and Media Grows

But a number of factors could put these company's days of trying to avoid paying their fair share at an end. Italy's government has become much more aggressive in terms of tax code enforcement as the nation's fiscal situation deteriorates. The nation's centrist Partito Democratico (PD) -- which gained a majority in recent elections -- has focused on cracking down on tax dodging as a way of fixing the nation's debt crisis.

In Ireland officials are facing pressure from their EU and U.S. counterparts. A growing coalition of academics, small business owners, the media, and taxpayers at large in the U.S. and EU are growing outraged at the tax dodging by many top firms. As Robert B. Reich, a professor of public policy at the University of California at Berkeley puts it in a comment to Bloomberg:

[Lost tax revenue] has to be made up by you and me and every other taxpayer who can't afford high-flying attorneys and accountants to shift our income into places with low taxes.

In other words, you might be paying 30 cents out of every dollar to the federal government in the U.S., but Apple only paid 3 cents.

One of the biggest problems about that is that it creates a massive barrier for market entry, as new firms have to try to compete against veteran companies like Apple while the government strips away a far bigger chunk of their profit.

Lobbying payoffs to politicians has resulted in small companies having to pay much more than their large competitors, making the "free market" not so free. [Image Source: i-Sight]

In other words, the free market is not so free; in the U.S. and EU it's perhaps but a rosy political fantasy, as the true market creaks under the weight of rampant manipulation by special-interest funded politicians.

There is some desire for change -- particularly in cash-strapped EU states, who can't just keep borrowing more money (like the U.S. does). But even if these jurisdictions like Italy finally do try to shake down Apple and its peers for taxes, it's unclear whether they will succeed.